Market Crash Risk and the Cross‐Section of Stock Returns: Evidence in China

ABSTRACT This study proposes a novel model‐free market crash index designed to capture time‐varying left‐tail risks, which can be replicated using option portfolios. We construct market volatility and crash indices utilising SSE 50 ETF option data, subsequently investigating the pricing mechanisms of market volatility and crash risks across the cross‐section of stock returns in the Chinese stock market. Our findings indicate that stocks with high exposure to market volatility and crash risk tend to have significantly lower average returns. Notably, the risk premia associated with these factors become more substantial when excluding state‐owned enterprises or small‐cap stocks.